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Mergers and acquisitions
Fundamental analysis for share
valuation
Evaluation of a business strategy
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In the real market, a firm creates value by
earning a return on invested capital greater
than the opportunity cost of capital.
The more a firm invest at returns above the
cost of capital, the more value it creates
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A firm selects strategies that maximize the
present value of expected cash flows or
economic benefits
The value of a company’s shares in the
stock market is based on the market’s
expectations of future performance of the
company.
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After an initial price is set, the return
that shareholders earn depends more
on the changes in expectations about
the company’s future performance than
its actual performance.
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NOPLAT (Net operating profits less adjusted
taxes) represents the profits generated
from the company’s core operations after
subtracting the income taxes related to the
core operations.
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Invested capital represents the cumulative
amount the business has invested in its core
operations – primarily property, plan and
equipment and working capital.
Invested capital is the total of equity and
total borrowings in the balance sheet of a
company, reduced by the amount of nonoperating assets.
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Net investment is the increase in invested
capital from one year to the next
Net Investment =
Invested capitalt+1 - Invested capitalt
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FCF is the cash flow generated by the core
operations of the business after deducting
investments in new capital.
FCF = NOPLAT – Net Investment
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ROIC is the return the company earns on
each rupee invested in the business
ROIC = NOPLAT /Invested capital
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IR is the portion of NOPLAT invested
back into the business.
IR = Net investment/NOPLAT
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WACC is the rate of return that investors
expect to earn from investing in the
company and therefore, the appropriate
discount rate for the free cash flow
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‘g’ is the rate at which the company’s
NOPLAT and cash flow grows each year
If the company’s revenue and NOPLAT
grow at a constant rate and the
company’s IR is also constant, its FCF will
grow a constant rate
 Enterprise
Value =
FCFt+1 /(WACC-g)
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FCF =
NOPLAT – Net Investment
FCF =
NOPLAT – (NOPLAT x IR)
FCF =
NOPLAT x (1-IR)
g
= ROIC x IR
 IR = g/ROIC
 Technically one should use the
return on new or incremental
capital
 FCF
= NOPLAT x (1 – IR)
 FCF = NOPLAT x (1-g/ROIC)
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Value = [NOPLATt=1 ×(1-g/ROIC)]
WACC – g
 Value
drivers : Growth; ROIC;
and Cost of capital
 The
value of a company equals
the amount of capital
invested, plus a premium
equal to the present value of
the value created each year.
 Economic
Profit =
Invested capital x (ROIC –
WACC)
 PV of economic profit =
EP/(WACC-g)
 Value
=
Invested capital + PV of
projected EVA
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Value = NOPLATT=1 x (1-g/ROIC)
WACC – g
Value
= (1-g/ROIC)
NOPLATt=1 WACC - g
A
Company’s earnings multiple
is driven by both its expected
growth and its return on
capital
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NOPLAT =
Invested Capital x ROIC
Value =
Invested CapitalxROICx(1-g/ROIC)
WACC - g
Value
= ROICx(1-g/RONIC)
Invested Capital
WACC – g
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Drivers are : WACC;ROIC; and g
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Revenue growth
Profit margin (per cent)
Cash tax rate
Working capital/Revenue (per cent)
Capital expenditure/Revenue (per cent)
Cost of capital (per cent)
Value growth duration period (years)
◦ Value growth duration period represents the future
period for which the entity has a foreseeable
competitive advantage.